The Great Depression vs. the Millennial Slowdown

It's easy to dismiss the parallels between then and now as superficial, but the similarities still ring with unsettling echoes

By Amey Stone

With layoffs mounting, the stock market continuing to fall, and few signs that interest rate cuts are working their magic, you might feel like the economy is pretty bad off. Rest assured: This is nothing compared to the Great Depression.

In 1933, unemployment peaked at 25% of the work force (now it's 4.5%). The country's economic output declined by 30%. Today, people are wondering whether gross domestic product (GDP) could slip 1% this year. Nearly 70 years ago, more than 9,000 banks failed, eliminating the personal savings of millions of people. Consumer confidence was dashed, spending fell by one-fifth, investment collapsed, and wages and prices tumbled amid rampant deflation.

The underlying causes of the Great Depression -- what made it so severe and last so long -- is still "one of the great unanswered questions in economics," says Elmus Wicker, professor of economics at Indiana University in Bloomington and author of The Banking Panics of the Great Depression. Today's economists say chances are slim that such an economic catastrophe can happen again, mainly because the financial industry is much more regulated, banks are much better capitalized, and federally backed deposit insurance is in place. "Having been through the fire of the Great Depression, our institutions are a lot stronger and more prepared," says Mark Zandi, chief economist at consulting firm

Yet some unsettling parallels can be made between the current economic environment and the events leading to the Great Depression. Many economists point out that the similarities between then and now are mostly superficial. In fact, right now the consensus outlook is that the economy won't get much weaker before it begins to recover late this year or in the first half of 2002. In the face of that relative complacency, it's worth noting that there are no guarantees the economy is on the road to health. A look back to some economic forces we have in common with the 1920s shows why:

Consumers remained optimistic after stocks fell. Here's a little known fact about the Depression -- consumers actually remained fairly upbeat following the stock market crash in 1929. A 1979 article in a BusinessWeek issue analyzing the 50 years after the Great Depression noted: "The horror of the period was heightened by failure of most Americans, in the early months, to realize how bad it would be." In fact, the first half of 1930 saw a modest pickup. When that failed, "People felt the ground give way beneath their feet," Harvard economist Joseph Shumpeter wrote.

It seems that it took a while for investors' faith in the strength of the economy to fade. In that same article, noted economist John Kenneth Galbraith commented that a depression was unlikely to happen again because there was no stock market bubble at that point. Said Galbraith: "It would be hard to find any build up of speculative hubris that would make us as vulnerable as we were in 1929."

Wonder what he would think of 1999? Edward Deak, an economics professor at Fairfield University, notes that consumers today are continuing to spend, taking out loans against their homes and increasing credit-card balances because they're betting this will be a brief slowdown. "That is a reasonable view," he says, adding: "But I don't think it is a slam dunk." Deak says he'll be watching closely to see if unemployment spikes or the back-to-school shopping season is weak. If either happens, he'll be more worried than he is now.

Robert Smith, president of Smith Affiliated Capital, thinks consumers, like businesses, should be more conservative, given the possibility the economy may deteriorate further. "They aren't doing much to protect themselves," he says. He recommends that investors add bonds to help stabilize their portfolios. Drawing a marine analogy he says, "When there are high waves, to maintain forward speed you need to put more ballast in the boat."

The stock market continues to slide. While economists are pretty much in agreement that the stock market didn't cause the Great Depression, the crash of October, 1929, did play a role in eliminating wealth and forcing consumers to stop spending. "It contributed to the seriousness of the Depression," says Wicker, who calls the stock market's current slide "a little mini-crisis" by comparison.

Today's declines, while not as precipitous, are playing a role in the economic slowdown. And "stock market declines are going to continue to have an effect on consumers' ability to spend," Deak says. For example, he thinks the impact will show up in the Northeast come annual bonus time on Wall Street, when investment professionals will be lucky if they get 40% to 60% less than last year.

Cash is being conserved. In the Great Depression, it was ordinary folks who hoarded any cash they had. Now it's business managers who are reluctant to spend. They're cutting expenditures on advertising, high-tech equipment, and, most important for the overall economy -- payrolls. "They are guarding cash," says Smith. "They don't want to run out of it."

The continued decline in information technology spending is the clearest example. A recent Wit Soundview report notes that IT managers had spent a smaller percentage of their full-year budgets in the first half of the year than usual. Because they expect their already-slashed budgets will be cut more in the second half, they appear to be guarding what spending power they retain.

We may not be in an official recession now thanks to the continued strength of consumer spending, but "this slowdown has been triggered by substantial, recession-level declines in business capital spending," says Deak, noting that, so far, business investment spending hasn't been bolstered by cuts in interest rates. When it comes to holding up the economy, for now, "consumers are carrying the burden here," he says.

As long as consumer spending holds up until corporate profits rebound, the economy should be able to avoid recession (see BW Online, 8/20/01, "Can the Consumer Go the Distance?"). But if increases in unemployment cause consumer confidence to crack, the economy could worsen.

Mutual funds -- or their 1920s equivalent -- were very popular. A smaller point, but a significant parallel nonetheless. Yale University economist and financial historian William Goetzman says in the early part of the last century, consumers -- albeit a much smaller percentage of the population than today -- were also drawn into the market through pooled investments comparable to today's mutual funds. Overall, he says, it was and remains "a wonderful thing" that small investors had the benefits of diversification and low transaction fees provided by funds.

However, he speculates that diversification may have made people willing to pay more for stocks because they felt protected. While he declines to draw a tie between the Great Depression and that factor, he says it's a parallel between then and now worth noting.

Global economies are linked. The past two decades have been characterized by increasing international investing and stronger trade ties in the global economy. But believe it or not, the first three decades in the last century were a period when trade flows were crucial to the U.S. economy.

"It was sort of a golden age of world capital markets," says Goetzman, who sees this as the closest correlation between today's economic picture and the events leading to the Great Depression. Then, economic crisis spread from one country to the next, mainly thanks to the gold standard -- to which most major countries had their currency pegged. Back then, countries, including the U.S., hiked interest rates to protect their currencies and imposed tariffs that clamped down on trade -- exactly the worst moves they could have made, economists say.

Knowledge of those policies' harmful ramifications is precisely why hardly anyone thinks the U.S. could possibly make the same mistakes it made then. "Then the Federal Reserve was a new institution," says Wicker, adding: "There is no comparison with what the Fed knows today and what it knew then." But as much power and as much expertise as today's Fed possesses doesn't mean it would able to save the day if global economies continue to deteriorate.

"Today, three economic engines are sick, Germany, Japan, and us," Smith says. Suffice it to say, weakness overseas could touch off currency woes that would make matters worse in the U.S. "The policymakers overseas better get going," says Zandi.

In the end, a repeat of the Great Depression is highly unlikely, experts agree. If things did start to unravel the way they did back then, regulations and structures are in place that would be able to contain the fallout and prevent another disaster of similar magnitude. That doesn't mean, however, that things can't get worse from here. And the parallels are worth noting. For investors, it makes sense to remain cautiously alert until signs of a rebound emerge.

Stone is an associate editor of BusinessWeek Online and covers the markets in our daily Street Wise column

Edited by Beth Belton

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